Hot or Not? London Offices Split in Two in Historic Divergence

(Bloomberg) -- For the first time ever, London office rents are set to go in two different directions.

Rents for the capital’s new and old office spaces have tended to move in tandem in the past. Yet demand for the best space is expected to push rents for those buildings up over the next few years, while second-hand offices may see falling rates, creating a two-tier market with big winners and losers.

Landlords with new buildings sporting the latest features can charge record prices even in a market fraught with uncertainty over Brexit. That’s because companies are increasingly focused on attracting and retaining staff whose expectations about what offices should look like have been raised by flexible-working companies such as WeWork Cos Inc. and tech giants like Google and Facebook Inc.

“In the last four years, I have seen the biggest shift in occupier expectations and thinking,” said Colette O’Shea, managing director of the London portfolio at Land Securities Group Plc, the U.K.’s second-largest real estate investment trust. “We are seeing it in every aspect of life. It’s all about quality and flexibility. People are prepared to pay for something that they think is good value.”

A shortage of development in recent years has driven supply of new London office space to the lowest since 2001, according to a study to be published Thursday by CBRE Group Inc. At the same time, the availability of second-hand space has surged to account for nearly three-quarters of total vacancies in the capital, a 16-year high.

The CBRE report forecasts that rents for new buildings will rise by 2 percent a year through 2022 as those on excess space in older buildings fall by 1 percent a year.

“It used to be the finance director who made the decision” on office moves, said Julian Agnew, chief investment officer for the U.K. at LaSalle Investment Management. “It is now human resources who make the decision.”

Advances in building design are also having an effect. By allowing more workers to be packed into much less space, the efficiency gains are helping businesses to sign up for shiny new properties while still keeping a lid on costs, in turn boosting rents at the top of the market.

The demand for flexible office space in newer buildings was initially fueled by tech startups and freelancers that might have otherwise rented older spaces. Increasingly, though, large companies are seeking flexible offers from the likes of WeWork to provide locations for teams away from corporate headquarters.

WeWork has been able to offer relatively cheap space with the extras younger workers now expect. That’s despite the company itself having to pay building owners historically high rents.

“The co-working phenomenon has fundamentally changed people’s expectations of what is acceptable” in terms of office design, said Simon Brown, an analyst at CBRE who co-wrote his firm’s report.

The divergence between the best and the rest in London offices has also confounded expectations that Britain’s impending exit from the European Union would lead to a blanket collapse in rents.

While WeWork is responsible for a large chunk of the demand that has cushioned the Brexit shock, the growth of the flexible-office model has also prompted London’s biggest REITs to respond with their own platforms. Both Blackstone Group LP and Tishman Speyer are venturing into flexible-space offerings. And the proof that demand for good space remains strong has prompted REITs to re-stock their development pipelines.

“It is amazing it took us so long to accept that customer care is so important in the office market,” Savills Plc head of commercial research Mat Oakley said. Landlords should “take off the Brexit blinkers and focus on the things that really matter.”

To contact the reporter on this story: Jack Sidders in London at jsidders@bloomberg.net

To contact the editors responsible for this story: Sree Vidya Bhaktavatsalam at sbhaktavatsa@bloomberg.net, Paul Armstrong, Marion Dakers

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